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Navigating The Choices

Tax planning is not regulated by the financial conduct authority.

You now have far more freedom in how you use your retirement savings.

However, this freedom of choice can have implications if you get it wrong. For example, you may create a large tax bill that you wouldn’t otherwise have had. Also, not all your pension plans may allow this new freedom of choice. You may have to move the money to an environment that does allow it. This might be a good thing to do; it might just as easily be a bad thing.

You can avoid getting it wrong with the right advice.

Taking a tax-free lump sum

You can take 25% of your pension fund as a lump sum, completely tax free. This hasn’t changed and has been this way for many years.

Creating a retirement income

There are two ways you can use your pension to do this: buy an annuity or invest in flexi-access drawdown.

Annuity

An annuity will pay you an income until you die. Guaranteed. This is the annuity’s big advantage and makes it the starting point for all your retirement planning.

We believe it’s essential for you to receive a regular income to cover your day-to-day expenses. However, guarantees come at a cost.

The amount of income an annuity pays you depends on two things: the size of your pension fund, and how long you might live based on how old you are now. So the older you are the more income you will receive. Your annuity payments form part of your total taxable income and incur income tax.

You can also choose what type of annuity you have:

  • One that pays you a guaranteed income until you die and then stops or
  • One that pays you a guaranteed income until you die and then continues to your surviving spouse or dependant
  • One that stops paying as soon as you die or
  • One that guarantees to pay out for a minimum time, for example five years, even if you die earlier
  • One where the income stays the same or
  • One where the income increases each year.

The value of pensions and investments can fall as well as rise, you may get back less than you invested.

Each option you add makes the annuity more expensive and reduces the income it pays you. Your Ablestoke adviser will be able to help you make the right choice for your circumstances.

Shopping around – the open market option

You do not have to accept the annuity your pension provider offers you. If you do one thing and one thing only, make sure you shop around for the best annuity you can get. This may sound like obvious advice but around 60% of retired people do not. (Source: Financial Conduct Authority – 2014 thematic review.)

Shopping around for the best annuity can make an enormous difference to your retirement income.

Flexible Access Drawdown

Income drawdown has been around for a while but there were restrictions wrapped around it. These restrictions have now gone, creating flexi-access drawdown. drawdown as a bit like a bank account. You keep control of your pension fund, investing it and drawing down income as you need it, when you need it. You have completely flexibility over how much you take out and how often you take it. Once you have drawn your 25% tax-free cash entitlement any further withdrawals form part of your total taxable income and incur income tax.

The complete flexibility that flexi-access drawdown gives you is its big advantage. On the downside it brings two big risks:

  • You don’t make the investment returns you need to support your withdrawals
  • You withdraw too much too quickly and run out of money. We call this the 'risk of ruin'

Take it all as cash – the Uncrystallised Funds Pension Lump Sum (UFPLS)

As long as you are at least age 55 you can cash in your pension fund provided you haven’t already touched it. If you cash in your entire pension fund, 25% will be tax free and the other 75% will form part of your taxable income and incur income tax.

The advantage of UFPLS is the way it enables you to access a large amount of cash, perhaps to generate retirement income in other forms, property for example.

The disadvantages are twofold:

  • The temptation to spend it on luxuries such as holidays and nice cars
  • The tax you will inevitably pay – you may lose as much as 45% of the taxable portion in tax. Be clear: even if you are usually a basic rate taxpayer, the lump sum from your pension fund could quite easily elevate you into the highest tax bracket.
Guide to Retirement Download

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